No respite in sight for chemical stocks as export headwinds persist

A combination of weak export demand and high input costs have dampened quarterly earnings of chemical companies. (Photo: Bloomberg)
A combination of weak export demand and high input costs have dampened quarterly earnings of chemical companies. (Photo: Bloomberg)

Summary

  • While a recovery seems on the horizon, it is expected to be gradual, with Q3FY24 likely to show muted performance

Over the past year, Indian chemical stocks have not kept pace with the broader market, underperforming the Nifty 50 index, which has climbed nearly 20%. Key chemical companies like SRF have seen a modest gain of around 7%, whereas UPL Ltd and Navin Fluorine International Ltd fell about 27% and 15%, respectively. This downturn contrasts sharply with their impressive performance in 2022, when gains for these stocks ranged from 30% to 120%.

This underperformance is the combination of weak export demand and high input costs, which have dampened quarterly earnings. Companies like UPL, SRF, and Navin Flourine, which generate a significant portion of their revenue from exports (82%, 51%, and 66% respectively in FY23), have been particularly affected.

The first half of fiscal year 2023-24 saw a pronounced impact of weak exports, and expectations for the December quarter (Q3FY24) remain low. Typically, Q3 is a seasonally weak quarter, given the holiday season in Europe and the US.

According to Centrum Broking, UPL is expected to report a year-on-year decline in sales and Ebitda. SRF would follow suit with a year-on-year and a sequential drop in sales, hurt by sluggish exports. Navin Flourine is expected to report a year-on-year dip in revenue and Ebitda, but should see growth sequentially. Ebitda stands for earnings before interest, tax, depreciation, and amortization.

However, there are emerging signs of recovery in exports. European chemical production saw a slight uptick of 0.5% in the third quarter of calendar year 2023 (Q3CY23), the first positive movement in six quarters, despite a significant 10.6% year-on-year drop in the first nine months of CY23.

The numerous challenges that faced the global chemicals industry in 2023, including a European recession, US inflation, and slow demand recovery from China, are showing signs of easing. The American Chemistry Council forecasts a modest 1.5% rise in US chemical production in 2024 after a 1% decline in 2023, with global output expected to grow by 2.9% year-on-year. As per the Council, destocking, which began in Q3CY22, has largely concluded, but restocking is yet to commence.

Specialty chemical stocks like Navin Flourine and SRF, however, may continue to face pressure due to the phasing out of certain refrigerant gases in the US, which may curb revenues from exports. Furthermore, recent attacks on commercial carriers in the Red Sea have led to higher freight rates and insurance costs, with extended voyage times impacting supply chains and profitability.

While a recovery seems on the horizon, it is expected to be gradual, with Q3FY24 likely to show muted performance. UPL, in its Q2FY24 earnings call, acknowledged the difficult phase in the global agrochemicals industry, marked by significant price drops and distributor destocking in key regions like Brazil, North America, and Europe.

Despite these short-term challenges, Indian chemical stocks may be gearing up for a rebound. Early indicators of a global recovery in the chemical sector hint at a potential revival for Indian companies, with Centrum Broking predicting a sharp upturn in FY25E followed by normalization in FY26E. While the immediate future looks subdued, long-term investors might find attractive opportunities in these currently undervalued stocks, with their price-to-earnings multiples now in the range of 12-44 times, compared to 21-77 times in January 2022.

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